One vehicle used by consumers to build assets for retirement (or otherwise over a long-term basis) are deferred annuity contracts. Traditionally, companies offering such annuity contracts use two methods to determine the account balance to credit interest earnings to the holder of the contract. One such method is known as the Portfolio Method, and the other method is known as the New Money Method.
Under the Portfolio Method, a deposit received by the company in any year of the contract earns the same interest as deposits made in prior or later years. Under the New Money Method, deposits made in a given period receive the new money interest rate. Deposits made in prior or later periods receive the then-current new money rate. Some companies maintain the new money interest indefinitely, while other companies roll the interest into a Portfolio Method rate after some period of time.
There are several shortcomings associated with these traditional earnings methods. First, the use of these methods results in inconsistency within the industry, and do not reflect the current interest rates that the company is earning on such deposits. A portion of the company's portfolio is updated by a combination of scheduled maturities, coupon payments, and called investments. This could allow a company the opportunity to reinvest; however, none of the traditional earnings methodologies captures such reinvestments and credits them to the contract holders.
The Portfolio Method and New Money Method generally work well in either a steady rate environment or a declining interest rate environment. Neither work well, however, in a rising interest rate environment. Specifically, for the Portfolio Method, the portfolio will be below new money interest rates. Such a shortfall means that the company will find it difficult to attract new investments by contract holders or new contract holders. The Portfolio Method account will reflect the old rates being used. For a rising interest rate environment, the New Money Method uses rates that are current for new contracts or new deposits, but the old money rates remain unchanged. Again, this means the company finds it difficult to keep existing customers. In both cases, the contract holders do not receive the benefit of increasing rates to their accounts.
Therefore, it is desired to provide a system and method for calculating credits to an annuity contract that works in environments of steady, decreasing, and increasing interest rates. It is also desired to provide a method for determining earnings for annuity contracts that provides credits for reinvestment of investments experienced by the company holding such contracts.
A system and method for annuity valuation should also provide for numerous variants. In this manner, a company has flexibility in the annuity products it offers, and different companies can distinguish their products from each other. It is therefore desired to provide a system and method for annuity valuation having flexibility in the type of annuity product offered.